How North American production has helped bring ‘calm’ to oil prices

The Middle East is convulsing and oil demand is expected to grow ahead of the well-travelled Labour Day-long weekend.

It could have been a recipe for a hefty risk premium. Instead oil prices are hobbling near a seven-month low, closing Tuesday at US$93.86, up US$51¢, on the New York Mercantile Exchange.

It’s an indication of the economic and political freedom gained from growing production of oil in the United States and Canada.

An eerie calmness in the face of what is perceived as mounting geopolitical risk

Too bad that what should be a moment of pride will be mostly unsung after the environmental movement turned the North American technology-enabled oil surge — whether from Canada’s oil sands or tight oil deposits in the U.S. — into a source of shame.

Oil prices “sort of have an eerie calmness in the face of what is perceived as mounting geopolitical risk that spans a rather large part of the oil producing world,” said Judith Dwarkin, director, energy research, at ITG Investment Research in Calgary.

“The way prices are behaving suggests that the market is fairly confident that the production increase to meet demand in the second half of the year will be there.”

West Texas Intermediate crude recovered Tuesday from a seven-month low on renewed optimism for the U.S. economy.

According to the EIA, the U.S. Department of Energy’s statistical arm, U.S. crude production will reach 8.46 million barrels a day this year and 9.28 million in 2015, the highest annual average since 1972.

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Many U.S. oil and gas companies have moved away from producing natural gas, where prices have been low because of the discovery of massive shale deposits, to oil, where new technologies have also unlocked new fields, but for which prices have been stronger.

“On average, revenues per barrel have increased by double the percentage of the gas producers and the difference between the respective increases in operating netbacks is very striking,” said Mark Young, senior analyst at Evaluate Energy and CanOils, in a report.

“This has also translated into higher cash from operations in the financial statements. The market has also clearly approved of the switch to oil, with market caps for the oil producers now nearly 70% higher than they were in 2012.”

In Canada, oil production — primarily from the oil sands and increasingly from tight oil — will rise to 3.68 million barrels a day this year, and to 3.91 million barrels a day in 2015, according to a June forecast by the Canadian Association of Petroleum Producers.

Growing North American production has even helped “calm the waters” outside the continent, Ms. Dwarkin said, as oil that would normally be imported is turned away and pushed into the world market, keeping world prices like the Brent benchmark from “going bonkers.”

World oil prices are also responding to increasing supplies from Libya, uncertainty about how unrest in the Middle East will impact supplies and the failure of sanctions to curtail Russian oil.

The production growth has deflated speculators, who are the least bullish on U.S. crude prices than they have been in 16 months, according to Bloomberg News. Bullish bets on Brent benchmark prices are at the lowest level in two years, data released yesterday by the ICE exchange show.

Oil prices could pinch high-cost Canadian oil sands producers.

But oil sands supply costs — which include capital spending, operating costs, royalties and taxes and a rate of return — remain well below current oil prices.

According to a new report by the Canadian Energy Research Institute, that cost is $50.89 a barrel for new projects that use steam-assisted gravity drainage, $71.81 a barrel for standalone mining projects and $107.57 a barrel for integrated mining projects.
With costs increasing in Alberta, some oil sands developers are “taking their foot off the gas,” said David Yager, national leader of oilfield services at MNP LLP, in a report to clients.

He pointed to the cancellation of the $11-billion Joslyn mining project by Suncor Energy Inc. and Total SA, as well as setbacks at smaller operators like Sunshine Oil Sands Ltd. And Southern Pacific Resources Ltd. “Nothing major … but the cumulative impact will be felt by oilfield services operators that have grown to depend upon Northeastern Alberta for all or part of their revenue and profits,” Mr. Yager predicted.

But you won’t find producers whose plants are up and running crying the blues just yet. Canadian oil is primarily sold in the U.S., so the low Canadian dollar is softening the impact of weaker oil prices. And discounts for bitumen have narrowed thanks to increasing rail and pipeline transportation options.